Bank of Canada 'more comfortable' after inflation pick-up

By Louise Egan | Small Business

By Louise Egan

SYDNEY (Reuters) - Two months of stronger inflation in Canada has made the central bank feel a "little more comfortable", Bank of Canada chief Stephen Poloz said on Saturday, signaling that he may feel less pressure to cut interest rates to deal with disinflation.

Poloz also told Reuters the value of the Canadian dollar will remain a challenge for manufacturers and exporters even as the U.S. economy recovers, because higher prices for commodities that Canada exports would prop up the currency.

Speaking before a meeting of finance ministers and central bank chiefs from the Group of 20 leading economies in Sydney, Australia, Poloz said data on Friday showing the inflation rate rose to a 1-1/2-year high of 1.5 percent in January from 1.2 percent in December indicated the surprisingly low prices seen in 2013 may have been just "noise".

"In your heart you're hoping that some of it is noise and that other bits of noise will offset it, and in the wash you find that the underlying inflation rate isn't falling really rapidly," Poloz said.

"So in that sense it's reassuring. It's helping us to feel a little more comfortable."

Still, Poloz said there was nothing in the data to make the central bank rethink its forecast that inflation will hover at around 1 percent in the first half of this year before returning to the 2 percent target in about two years.

Poloz, 58, took over as central bank chief last June. In October he oversaw a major policy shift because of growing worries about disinflation, saying policymakers were puzzled by the trend. The central bank abandoned 18 months of talking about eventual interest rate hikes and adopted what it called a neutral stance.

In January, Poloz said he was even more worried by disinflation and left the door open to a rate cut. Inflation has been below the central bank's target for 21 months.

Most economists expect the bank to hold its main interest rate at the current 1.0 percent until 2015, when it will begin raising rates. Traders are still pricing in a small chance of a rate cut later this year, although they scaled back those bets after the inflation data.

Poloz endorsed efforts by some G20 members gathered in Syndey to set a higher goal for global growth, but said it should be seen as aspirational rather than a hard target.

CURRENCY CHALLENGE

The Canadian dollar has depreciated by about 7 percent against the U.S. dollar since October, a relief for exporters whose products become more competitive in their main market, but Poloz said the pain was not over yet for exporters.

"Even though the (Canadian) dollar has come down off its peaks, it still remains a challenge for certain companies like manufacturers ... It looks like it would remain so because the terms of trade is so high, 25 percent higher than it was back in the 1990s," he said.

In its quarterly report in January, the central bank characterized the currency as still "strong". Poloz said that was meant "to remind people that those things don't go away just because we get a recovery from the U.S. recession, which is there".

"Other forces that are thrown into action by a terms of trade shock, many of which are sectoral and regional ... Those characteristics will persist for a really long time. They don't go away just because the recession is over," he said.

Poloz, who formerly headed the country's export credit agency, dismissed talk among some market players that he is deliberately seeking a weaker dollar to help exporters, saying the currency move was a consequence of factors such as the changing economic outlook and firmer U.S. recovery.

"I think you can tell a reasonable story and it's got nothing to do with anybody talking the dollar up or down," he said.

The weaker currency gives "a little extra kick" to the economy, but the main driver of exports is demand from the U.S. market, he said.

Canada's economy appears to have stumbled in December after a five-month growth spurt. Retail sales, jobs, manufacturing and the trade deficit all deteriorated in the month, possibly because of a severe storm that hit a large swath of the country and cut off power for days in Toronto.

Poloz said more data was needed to determine whether the setback was due to bad weather mainly or reflected an underlying trend.